Cannabis could be big for industrial real estate market

The cannabis industry is on an explosive growth spurt, and some real estate professionals are banking that will lead to big profits. One of the reasons: People in the pot business aren’t exactly being welcomed with open arms, so finding suitable sites to run their operations is both a challenge and an expensive proposition for them.

However, if you’re cool with renting to cannabis entrepreneurs, the upside could be quite heady.

“Most landlords don’t want to lease to cannabis tenants, and so there is a very limited amount of supply,” said Chris Ly, director of alternative investments at San Diego-based McKinney Capital & Advisory. “So rents are much higher.”

McKinney is banking on the fact that most landlords will continue to avoid the industry, keeping rents at two to three times the market rate. The commercial real estate investment, asset management and brokerage firm is investing in industrial space for cannabis and offering consulting services.

The cannabis industry is expected to grow from its current $6.5 billion size to $25 to $30 billion by 2021, as more jurisdictions legalize marijuana and operations become more professional, experts predict.

In California, it is estimated that cannabis will hit $3.7 billion in 2018, now that recreational marijuana is legal. BDS Analytics, a cannabis industry research firm, estimates that number will increase to $5.1 billion in 2019 as more dispensaries come online. That would mean the industry will surpass beer sales in the state, which were $5 billion in 2017.

McKinney sees great investment opportunity in such growth. It acquired a 61,000-square-foot building in Oakland for $12 million and leased it to cannabis industry tenants.

“We call it a Canaworks campus,” Ly said. “There is massive synergy with different types of cannabis businesses working together.”

The building includes tenants that handle extraction, analytics, edibles, packaging and distribution.

“It has everything except for indoor cultivation, which we don’t want because that requires a lot of power,” Ly said. “Manufacturing creates oils. They give them to the edible group, and it gets tested by the analytical lab.”

The industry is highly regulated, and many of the tenants need medical grade labs in order to meet state requirements.

“We got into the industry because in Colorado and Washington, the industrial market was impacted dramatically by cannabis,” Ly said.

Indeed, most new industrial tenants in Colorado were in the cannabis industry, he said. San Diego already has a tight industrial market, with vacancy around 4 percent. That could mean that whether industrial property owners jump into cannabis or not, the growth of the market could make this a golden age for industrial real estate.

McKinney is not the only real estate company focusing on the cannabis industry. Innovative Industrial Properties launched as a real estate investment trust last year, focusing on medical-use cannabis facilities for acquisition. It is also based in San Diego, but looking to acquire properties nationwide and lease them back to cannabis growers under long-term lease agreements.

McKinney is consulting on a property in Mira Mesa that, assuming it gets city approvals, will begin to lease in six months and start construction in a year.

“In commercial real estate, landlords typically give tenants an improvement allowance,” Ly said. “In cannabis, you don’t give any allowance. So the space is higher rent than market rate and the expectation is that they will spend their own money to upgrade the facility.”

He said tenants could spend as much as $4 million to upgrade the Mira Mesa site.

There is risk, however, as marijuana is illegal under federal law.

“You have to look at the risk and reward,” Ly said. “But the storyline of what has happened is that there have been no federal raids or forfeitures in four years. There is always the potential that something catastrophic could happen. But the worse case scenario for us is that we have to rent to non-cannabis tenants at market rates, instead of two to three times that.”